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February 2016

There are tons of articles about the retirement readiness of Americans in general. What is much more rarely discussed is the retirement readiness of high income earners.

This reflects the fact that 6-figure earners represent a smaller segment of workers overall. But it also reflects the common perception, even among high earners themselves, that those who earn a lot will be “just fine” in retirement.

However, retirement readiness is relative, and when measured by income replacement ratios, high income earners often fall short. How is this possible?

There are several contributing factors, and these three stand out:

Responsibility for more. When it comes to percentage of pay, high earners receive less in Social Security benefits. This means they must supply more of their own income in retirement. Consider the graphic below from a Dimensional Fund Advisors white paper. The chart shows that even though those in the top quartile of income replace more of their income with savings, it still isn’t enough make up the hole left by Social Security.

Limitations. It can be a challenge for many people to meet the pretax 2016 contribution limit of $18,000 for workplace retirement plans. But for a physician making $200,000, it represents less than 10% of her pay—a savings rate unlikely to get the job done, in part because of the reason given above. Any additional savings would need to be made after-tax (i.e., without a helpful reduction in Federal taxes for each dollar saved).

Earn more, spend more. Having a higher standard of living before retirement means you’ll need more income to continue that standard post-retirement.

The solution to these challenges is in the discipline of saving more on an after-tax basis. Keep in mind that it isn’t your gross level of income that will buy you financial security, but the decisions you make about how to allocate that income stream. It will mostly come down to the relative percentages you direct toward consumption and toward savings.